FIXED EXCHANGE RATE

 

This is the system where the exchange rate is fixed and found rigid irrespective of changes in the demand and supply of exchange. This rate is fixed by the government by means of pegging operations.(Buying and selling exchange at a particular rate). Government follows exchange control to keep the rates stable. It helps to reduce the exchange reserves.

MERITS:-

1. Promotes trade:-  As the exchange rates are stable, international trade is promote without any speculation and forecasting.The fixed exchange rates creates certainty and assurance in the trade. it helps to increase trade world wide being uncertainly to be occurred in future transactions.
2. 
   Promotes growth of internal money and capital markets:- Fixed exchange rate system is good for the small nations as their transactions are small and need highly certainty and surety. It minimizes risk. It promotes growth of internal money and capital markets. Since flexible exchange rates cause uncertainties about the future exchange rates, individuals, companies and institutions are reluctant to lend to and borrow form the internal money and capital markets.
3. 
   Controls inflation:- Fixed exchange rate helps to maintain the external value of the currency stable and thus controls inflation. It prevents the Government of the countries form adopting inflationary policies. Generally, GOI have often been tempted to pursue undue expansionary fiscal and monetary policies to lower unemployment and create boom conditions.
4. 
   Simple and systematic:- The economic transactions between nations has become too complex that it is advantageous to follow a fixed exchange rate system. it systematised the worlds monetary system.
5. 
   Exchange rate stability:- A stable exchange rate helps to achieve internal economic stability and avoids problems of hoarding, decline in investment and unemployment. It would be very difficult in the fluctuating exchange rate system. It should be noted that for developing nations a stable or fixed exchange rate system has special advantage because they have persistent balance of payment deficits.
6. 
   No speculation:- Being fixed in nature, there is no chance to speculate the fluctuations in the exchange rates. Certainty in the rates is highly featured in this method.
7. 
   Capital movements:- Fixed exchange rates ensures the regular flow of the international capital movements. Since investors are assured of regular returns, FDI is encouraged. It also supports the growth of money and capital markets. It facilitates capital movement by private firms. A stable currency does not involve any uncertainties about capital loss on account of changes in exchange rate.

DEMERITS:-

1. Lacks adjustment mechanism:- The greatest defect of this system is that it lacks adjustment mechanism. This puts a great strain on the reserves of participating countries. The problem of this system is that to know to what extent exchange rate should be fixed.
2. Rigidity:- This exchange rate has been found more rigid and thus may create problem in promoting international trade. it prevents growth of multilateral trade being rigid in its nature.
3. Problem of liquidity:-  It creates problem of liquidity. Hence there had to be variations in exchange rates. It is found in the flexible exchange rates.
4. Difficult in real sense:- This system has to be supervised by an authority of the national government and international authority. There is also a problem of division of power between the two authorities to maintain fixed exchange rates.